Prior to 2007, buying property through a self-managed superannuation fund (SMSF) was restricted by the requirement that such property purchases could not be funded by borrowing. Since that restriction was lifted, the number of SMSFs investing in residential and commercial property has increased substantially making them major influencers in the Australian property market.
There are significant tax benefits to buying property through an SMSF, but there are also a few issues that fund trustees must understand before they embark on that pathway. The first is that the trust deed must permit direct property purchasing and borrowing and the second that this type of investment must be part of the overall SMSF investment strategy. This is important not only from the perspective of the Australian Taxation Office (ATO) but will be viewed as an acceptable borrower by lending institutions.
It must also meet the sole purpose requirement. This is set by the ATO and applies to the fund itself, and all the investment vehicles held by it. Essentially, this means that the fund must be maintained for the sole purpose of providing for the retirement of its members or their dependents, should any fund members die before retirement.
Funds that contravene the sole purpose test can lose their tax concessions, which are considerable, and the trustees may be subject to civil or criminal proceedings. Trustees must not, either directly or indirectly, receive a financial benefit while making investments on behalf of the fund, other than increasing the fund balance.
The ATO audits SMSFs rigorously, placing a large administrative and compliance burden on trustees.
Many of the SMSFs have been established by small business operators who are already busy running their businesses and time taken out by them to attend to their SMSF is time they are not spending on their business operations. Many SMSF trustees have relieved themselves of this administrative and compliance burden by getting the assistance of professional administrators like SMSF Assure.
Having considered all this, trustees need also to be aware that there are still restrictions on how that property is used. For example, the fund trustee, or any family members, cannot live in any residential property purchased by the fund. Small business owners, however, can buy a commercial property to lease back through their business. Again, however, there are conditions.
The terms of the lease must be commercially competitive, that is, the owner cannot lease it back at less than market value to give them a competitive edge on their business rivals.
- All rent payments must be made in full and on time. If the business goes through a downturn, the owner cannot forgo paying the rent to stay afloat until things improve.
- Part of the compliance requirements for this type of arrangement is that the owners must arrange regular valuations of the commercial property. These will be scrutinised at audit and are an additional compliance burden.
When an SMSF seeks finance approval for a property loan, things get even more complicated, much more so than getting a normal housing loan. Most lenders will be reluctant to lend more than 80% of the property’s value, so the rest must be provided by the fund. Lenders will typically include the income expected from the property into the borrower’s ability to make the payments. They will also be assessing the frequency and value of members’ fund contributions as these will also be included in the repayment obligations.
These types of loans are complex, so along with all the other hoops that fund trustees must leap through to get their investments off the ground, it is little wonder that they are seeking professional assistance. With the right advice, property investment is a very attractive vehicle for creating wealth for retirement, but without this professional assistance, it is time-consuming and stressful.
The final caution for anyone thinking of using their SMSF to purchase property through borrowing, is to not be so focused on the property market that they ignore or neglect other classes of investments. Public superannuation funds spread their investments across a broad spectrum of asset classes so that when one class is not performing, it is supported by those that are. The old saying of not putting all your eggs in one basket is still valid today, and a timely warning to be prudent when planning for retirement.